416-787-1366 | 1-866-228-9442 info@gicwealth.ca

DAVID ASTON, The Toronto Star

Your fixed income investments create an uncomfortable dilemma for you these days.

On the one hand, with so much pandemic-driven uncertainty about your stock market investments, you need a healthy chunk of relatively safe forms of fixed income to provide stability to your portfolio.

But on the other, with interest rates at ultralow levels, you earn very little yield for playing it safe with these conservative investments.

Unfortunately, you can’t fully escape this quandary. You can, however, make the most of these frustrating but necessary investments by choosing them wisely. You can enhance yields slightly with little added risk by going more for investment-grade corporate bonds than government bonds, or picking higher-yielding GICs offered by small institutions, and by keeping fees low.

Still, even with smart choices, you’ll probably end up earning a paltry yield of one to two per cent now if you’re sticking with low-risk forms of fixed income.

But their redeeming benefit is that they can be expected to largely hold their value if stocks suffer another big drop like that seen in March. You get those critical defensive qualities from investment grade government and corporate bonds (those rated BBB or higher by major bond-rating agencies), and GICs held within government deposit insurance limits (usually $100,000 per account type per institution).

Of course, you can get an enticingly higher yield of around four to five per cent by going with higher-risk “high yield” bonds (those rated below BBB). But if stocks suffer another steep downturn, high yield bonds can be expected to plummet by almost as much. So they don’t provide much protective power to your portfolio when you need it the most. Squeezing out bond yield If you’re a do-it-yourself investor looking to squeeze a little bit more yield out of investment-grade bonds, consider a good low-fee ETF (rather than mutual funds) and focus on corporate bond funds (rather than broad bond funds dominated by government issues).

If you do that, you can expect to earn a yield of a little over one per cent right now. As an example, the iShares Core Canadian Short-Term Corporate Bond Index ETF (ticker: XSH) has a yield-tomaturity of 1.26 per cent, according to the iShares website on Friday. After accounting for the management expense ratio of 0.1 per cent, that essentially leaves you with 1.16 per cent. An investment grade corporate bond fund like this will provide a fair bit of stability in a stock market sell-off, but it isn’t bulletproof and prices will likely suffer to a modest degree (but nowhere near as much as with high yield bonds).

While that’s not much yield, you could do worse. A broad-based shortterm investment grade bond ETF dominated by safer government issues can be expected to yield around 0.6 per cent after fees. That’s based on figures for the iShares Core Canadian Short-Term Bond Index ETF, ticker XSB, from the iShares website Friday. However, the heavy weighting of highly rated government issues in this ETF provides you with a lot of stability to compensate you for the puny yields.

Bond mutual funds come with higher fees than ETFs, which generally leaves you with less yield on a net basis.

Investment grade bond mutual funds intended for do-it-yourself investors (often designated as Series “D”) typically have management expense ratios of 0.7 per cent to 0.9 per cent. If you invest through an adviser in bond mutual funds with embedded advisory fees, expect to pay management expense ratios of about one per cent to 1.4 per cent. Good active bond mutual fund managers can add some value by savvy buying and selling of mispriced bonds, but it’s tough to make enough of an impact to offset such a big fee disadvantage compared to ETFs. Unfortunately, you should expect mutual fund fees to eat up a substantial proportion of whatever yield you earn.

You can also earn a little bit more yield going with longterm bonds instead of shortterm bonds. However, the extra yield for going longer term these days is not that much, making it of questionable benefit. If interest rates were to rise a little in a year or two from the ultralow levels they’re at now, you can expect bonds to experience capital losses to at least some degree. That’s because bond prices move opposite to interest rates, and long-term bonds are more sensitive to the impact of rising rates than short-term bonds. Underappreciated GICs One good fixed-income option that is often overlooked is GICs. The key to getting the best GIC rates is shopping around among smaller institutions, while staying within deposit insurance limits. If you do that, you should be able to find GICs paying around 1.5 to two per cent these days. As an example, Kevin Rotenberg, a deposit broker with GIC Wealth Management Inc. of Toronto, was able to source GIC rates of 1.65 per cent for one-year terms, and 2.1 per cent for five-year terms, as of Friday (with a minimum $25,000 amount).

While those rates won’t blow you away, they’re a lot better than what the large banks will give you. Posted one-year-GIC rates at the six major banks ranged from 0.15 per cent to 0.6 per cent on Friday, according to the Cannex.com website. (However, you can often negotiate a somewhat higher rate if you have a large amount to invest). The posted rate of 0.45 per cent for a one-year GIC at one of the big banks drew a sharp comment from Rotenberg: “It’s a shame when you have $100,000 and the bank is giving you $450 for it for a year, versus us getting you $1,650.”

These small financial institutions pay deposit brokers a fee for facilitating these deposits, so you can generally get a slightly better rate going direct to the financial institution, provided you’re willing to put up with the hassle of rate shopping and moving money around on your own. Ratecomparison sites like Cannex.com can help you rate-shop. Typically, financial institutions pay deposit brokers a one-time fee of 25 basis points (which is one-quarter of one percentage point) per year of term. (With GICs, unlike mutual funds and ETFs, you don’t have to be concerned about buried fees being deducted from your investments. These fees are paid directly by the financial institution to the broker.)

A major disadvantage of GICs is that you can’t generally redeem them prior to maturity without paying a substantial penalty, although an exception is usually made if the GICholder dies. (“Cashable” GICs are available, but they generally come with lower rates.)

One cardinal rule of buying GICs from smaller institutions is that you need to stay within deposit insurance limits. Most of these institutions are covered by the federal Canada Deposit Insurance Corporation (CDIC). CDIC guarantees up to $100,000 for eligible deposits per deposit type with each institution. You can effectively increase coverage at one institution by having $100,000 in your own non-registered accounts, $100,000 in a joint non-registered account with your spouse, $100,000 in a TFSA, and $100,000 in an RRSP. One tip is to invest slightly less than $100,000, such as $95,000, so the interest you earn can also be covered within the limit. The Financial Services Regulatory Authority of Ontario provides similar protection for Ontario credit union deposits, with a limit of $250,000 for non-registered accounts, and unlimited coverage for registered accounts. Reaching for yield While relatively safe bonds don’t yield much, you can get a more enticing yield by going with higher-risk “high yield” bonds. As an example, the iShares U.S. High Yield Bond Index ETF (hedged to Canadian currency, ticker XHY) has a yield-to-maturity of 5.45 per cent, according to the iShares website Friday. The management expense ratio is 0.68 per cent, so that would leave you with yield of less than five per cent after covering fees.

Understand that high yield bonds are relatively risky. While they generate a decent yield and seem to provide stability like safer forms of fixed income when times are good, their value tends to plunge almost as much as stocks during stock market sell-offs.

That typical pattern was amply demonstrated during the stock market meltdown in March. When the market hit bottom in March, the total returns on U.S. and Canadian stock markets were down a bit more than 30 per cent on a year-to-date basis. But U.S. high yield bond total returns were down just over 20 per cent in the same period, according to data cited by the Canso Corporate Bond Newsletter for June. High yield bonds don’t provide much stability when you need it the most. Fixed income for defence In my view, it is better to use the equity side of your portfolio for taking most of your investment risks right now. Despite the ultralow yields on relatively safe forms of fixed income, it makes sense to play it safe on that side of your portfolio.